Dynamic Equilibrium Details

In general terms, a dynamic equilibrium describes a state of balance between two processes. The term is used in scientific fields such as chemistry and physics which is where it originates. This article will explore what the phrase means in economic terms.

To understand dynamic equilibrium in economics, it is useful to start with what we mean by equilibrium. We can define both terms as follows. Equilibrium in economics is a situation where an economic variable (for example, prices, employment, or growth) remains stable.

Certain models of inflation are built from an assumption of dynamic equilibrium. Factors affecting inflation such as price level, nominal money supply, or wage rate shift over time, yet the inflation rate remains constant in the model.

Dynamic Equilibrium Examples

To take a simple example, the market price of rice remaining stable over time despite increasing supply and increasing demand would be a dynamic equilibrium. The variable, the price of rice, remains stable while the forces that affect the variable, the supply and demand, are changing.

Another notable example is the Solow-Swan model, a neoclassical economic model which attempts to explain long-term economic growth through technological progress. This model reaches dynamic equilibrium when the working population grows at the same rate as output and physical capital stock. The variables are changing, yet the system remains stable, again leading to what we can call a dynamic equilibrium.

Significance of Dynamic Equilibriums

The term dynamic equilibrium, and equilibrium in general, is used in models to describe theoretical scenarios but is rarely used to describe real-world situations. Market conditions are chaotic and mercurial, seldom leading to any kind of prolonged stability.

Economic variables are like a large-cap stock price. Even relatively stable stocks have enormous low-level volatility. Take a look at the stock price of your favorite blue chip for a single day, and you'll see violent jagged shifts in stock price on an hourly basis. Consequently, dynamic equilibriums are seen more in economic models where they can be used to predict behavior rather than something we use to describe the real world.

Static vs. Dynamic Equilibrium

A static equilibrium is an oversimplified description of real-world economics. It is common in introductory economic textbooks to assist beginners in understanding general concepts.

Imagine an apple on a table. The apple doesn't move, so the system is in equilibrium. The force applied by gravity is counteracted by the reaction force upwards from the table. Nothing is changing, so the system is in static equilibrium. Now imagine a strong wind blowing onto a heavy boulder. The force from the wind is constantly changing, blowing fiercely, then gently. The friction force on the boulder is constantly changing too to counteract the force of the wind. The forces in the system are changing, but the system remains in equilibrium, assuming the wind doesn't have enough force to move the boulder.

To bring this back to economics, the only time we do not see changing market forces is at a single isolated point in time. So, in economic terms, a static equilibrium is when there is no passage of time. In contrast, a dynamic equilibrium accounts for the passing of time and its consequences on the variable we are examining.